Intel's McAfee Buy: An $11.5 Billion Waste of Shareholder Money?

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intelBetween the $7.7 billion Intel (INTC) is paying for security software provider McAfee (MFE) and the $3.8 billion loss in Intel's market value after its Thursday announcement, the deal cost shareholders $11.5 billion. The stock has barely budged from its battered level in morning trading today, hovering around $18.94.

Although this purchase was intended to help Intel target the attractive mobile chip market, the combined companies will not be better positioned to compete there, they may be difficult to integrate, and the price Intel paid is way too high. The poor judgment behind this deal suggests that the semiconductor giant needs a new CEO.

With college classes just a week or so away, I'll be teaching undergraduate and MBA students an important concept about acquisitions -- most of them fail. To avoid such failures, deals should pass four tests:
  • Industry Attractiveness: Does the industry have high profit potential?
  • Better Off: Will the combined companies be able to get a significant share of that industry due to their combined skills?
  • Integration: Can the two companies merge their organizations smoothly so the deal is seamless to customers?
  • Price: Is the price paid for the target low enough so shareholders will get a return on the investment?
When the four tests are applied to the Intel/McAfee merger, the deal passes the first and fails the other three. Here's why:

  • Industry Attractiveness: PASS.The mobile chip market is huge, fast growing and profitable and expected to grow at a 22.3% compounded annual rate through 2013, with processors garnering an estimated value of $33 billion, according to InStat. The market research outfit expects the highest growth from hand-held applications like smartphones and mobile Internet devices. And the industry sports a 22.7% five-year average return on equity -- far higher than the S&P 500's 16.5% average.

  • Better Off: FAIL.To succeed in the mobile chip business, competitors try to outdo each other in meeting customer needs through "[product] performance, breadth of product offerings, access to customers and distribution channels, software support, conformity to industry standard Application Programming Interfaces, manufacturing capabilities, and [competitive] processor pricing and total system costs," according to Nvidia's (NVDA) 2010 10K. Although Intel claims that McAfee's security expertise is important to mobile device makers, this list of factors suggests that security -- while important -- is not important enough to customers to lead a flood of them to switch to Intel. Therefore, McAfee's capabilities will not enable the combined companies to gain market share.

  • Integration: PROBABLY FAIL.Intel, which makes most of its money designing and building chips, will have to manage the integration of McAfee, a designer and distributor of security software. While Intel has already decided that McAfee will be managed by its software and service group, the real question is whether the chipmaker will be able to manage McAfee's security experts so they work effectively in a team with Intel's mobile chip designers. Maybe it can, but it might have been more cost effective for Intel to hire dozens of security experts rather than buying all of McAfee.

  • Price: FAIL. Finally, Intel offered a 60% premium over McAfee's pre-deal market price in cash. Can Intel achieve more than $7.7 billion worth of additional profit from the McAfee acquisition within a few years? It's not likely. After all, McAfee only made $173 million in 2009 profit -- at that rate, it would take the deal over 44 years to break even. Meanwhile, it's a stretch to conclude that this deal would quickly enable Intel to make the billions in additional revenue from the mobile chip market needed to give its shareholders a return. No wonder the market chopped $3.8 billion off Intel's market value Thursday.
If Intel wanted mobile chip market share, it might have been better off buying a mobile chip maker. Perhaps it concluded that it could not do this because the price was too high, and antitrust laws would kill the deal. But I don't think the McAfee deal will help Intel achieve its aims. And I question whether Intel shareholders will get their $11.5 billion back from the profits it will generate in the mobile chip market.

This might be a good time to sell Intel stock because the shaky thinking behind this deal suggests that Intel management didn't do its homework.
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